In April 2022, Elon Musk entered into a legally binding agreement to purchase Twitter for USD$44 billion. As the ink dried on the contract, Musk began looking for a way to walk away from the deal.
Under the terms of the agreement:
Musk waived rights to conduct due diligence on Twitter's business;
there is a "material adverse change" trigger that would enable Musk to terminate the agreement, which Musk contends has been triggered by two events:
a. the assertion that there are significantly more bots and spam accounts on Twitter than the company had represented, and
b. allegations that key senior executives and staff had departed since the agreement was signed;
there is a "specific performance" clause, which recognises that Twitter may apply for an order to force Musk to complete the deal on the terms agreed; and
Twitter can recover a USD$1 billion reverse break fee from Musk for walking away from the deal in certain circumstances.
This begs the question: what might the outcome be if Musk's allegations of Twitter were unproven and he was therefore found to have repudiated the agreement; and if this dispute was heard by Australian courts?
Repudiation occurs when a contracting party fails to perform their obligations under a binding contract, whether willingly or where they are unable to do so.1
If Twitter can prove that Musk's actions have amounted to repudiation, Twitter may choose to:
- accept the repudiation, elect to terminate the contract and sue for damages; or
- elect to seek to have the contract performed.
In Australia, an array of monetary damages are available for a breach of contract. These are designed to place the non-breaching party in the position in which it would otherwise have been had the contract been performed.
Traditionally, the common (court-made) law has looked to the case of Hadley v Baxendale 2 , which provided that damages for breach of contract are recoverable if the loss:
- fairly and naturally arises from the breach (direct loss); or
- is reasonably in the contemplation of the parties, at the time they made the contract, as a probable result of the breach (consequential loss).
Under Australian law, contract makers must deal with this decision and ensure their contract explicitly states whether or not "consequential loss" (without further refinement of what this means) is recoverable if one of the parties is in breach.
However, in 2008, the Victorian Court of Appeal unseated the historical meaning of "consequential loss" as set forth in the second limb of Hadley v Baxendale.3 It decided, instead, that "consequential loss" should be given its natural meaning, and that the true distinction is between the "normal loss" that every plaintiff in a like situation would suffer, and any "consequential loss" that is beyond this normal measure of damages.4
This approach, however, has not been universally adopted across all Australian jurisdictions and until the High Court renders a decision on the meaning of "consequential loss", the issue will remain unsettled.
Consequently, when allocating risk through the use of a limitation of liability clause in Australia, contracting parties should not simply refer to whether or not "consequential loss" is remediable loss but, instead, carefully define what loss they actually mean (e.g., loss of profit, loss of revenue, loss of goodwill or loss of reputation).
Direct loss: Assuming a breach or repudiation by Musk is proven, Twitter would be able to recover the actual third-party costs of its transaction advisers and out-of-pocket expenses in connection with the failed transaction. There is no question of causation, as there is a direct connection between the buyer's breach and these kinds of specific expenses incurred by Twitter that would not otherwise have been incurred (i.e., paying legal counsel and other transaction advisers).
Consequential loss - loss of opportunity: In terms of consequential loss, the question arises as to whether Twitter's shareholders might be able to sue for a loss of opportunity in being unable to sell their shares at the initial offer price of USD$54.20.
Given Twitter's shareholders are not party to the takeover agreement between Twitter and Musk, there is first a question of whether shareholders are even contractually or otherwise entitled to damages. Shareholders might be found to be the holder of the benefit of Musk's obligations to complete the deal. This could arise, for example, if there was a binding guarantee to shareholders that the deal would close; or if Twitter was acting as trustee for its shareholders in connection with the offer and its negotiation. In such cases, it would be interesting to consider how shareholders might argue for a loss of opportunity.
Australian courts are yet to consider how consequential loss could be suffered by a seller in a mergers and acquisitions (M&A) context. Nevertheless, if:
- shareholders could show a breach of contract or other law; and
- the takeover offer did not exclude consequential loss,
then Twitter's shareholders might seek to recover expectation damages equal to the loss of their opportunity to sell their shares.5 To be successful, shareholders would need to show causation. More specifically,
(a) that Musk's breach caused the loss of a commercial opportunity that had some value to the shareholders of Twitter6; and
(b) actual loss which is not remote.
The High Court of Australia has shown a willingness to try to assess what actual loss has flowed even where some speculation is needed to come up with a dollar figure. In such cases, a court will assess:
(a) the prospects of success of Musk's bid had it been properly pursued, and
(b) the likelihood and degree of any benefits being realised by shareholders from such bid.7
If this could be shown, shareholders might then claim that they are entitled to the difference between the Musk bid and either the price of alternate bids and the company's market price or fair market value (in absence of an alternate bid). Notably, there have been no alternate bids since Musk's bid, but that is not necessarily fatal to a claim by shareholders.
More recent case law, however, demonstrates the challenge to courts in seeking to award damages for a loss of opportunity given the risk of overcompensating a claimant due to the inherent uncertainties involved in a hypothetical calculation.8
Market manipulation: Another avenue of compensation Twitter shareholders might pursue relates to grounds of market manipulation. Twitter shareholders in the U.S. have already brought proceedings on this basis against both Twitter and Musk in light of Twitter's falling share price.
Whilst Australia has provisions within the Corporations Act 2001 (Cth)9 prohibiting market manipulation - defined as where parties to a transaction create an artificial price for, in this case, Twitter shares - it is ultimately up to the Commonwealth or a public authority to prosecute offenders. Regarding compensation, shareholders may receive reparations under section 21B of the Crimes Act 1914 (Cth) as courts may order offenders to make reparations to any persons for any loss suffered by market manipulation.
Liquidated damages: As an additional consideration, provided the agreement contained a legally enforceable liquidated damages (or reverse break fee) clause, Twitter itself would be entitled to a fixed or agreed sum following Musk's refusal to complete the transaction. In such circumstances, Twitter would not need to prove its loss - the agreed reverse break fee is, in essence, a pre-agreed amount of Twitter's loss. However, to be legally enforceable in Australia, the clause would need to be compensatory, not punitive.
In deciding whether a liquidated damages clause is enforceable, or void as a penalty, Australian courts traditionally followed the Dunlop test,10 meaning that the quantum of liquidated damages would need to be a genuine and reasonable pre-estimate of the loss that would actually be incurred and suffered by Twitter, as the non-breaching party.
In 2012, the High Court refined the doctrine and held that a clause would be deemed a penalty, and become unenforceable, if it requires excessive payment that is not proportional to the pre-estimated loss.11 For some context, on public markets deals, it has also been fairly common market practice to place the quantum of reverse break fees at around 1% of the deal's value (in line with the Takeovers Panel's guidance on break fees and what quantum would generally be regarded as acceptable). However, adherence to such a rule of thumb will not protect a reverse break fee from scrutiny against the High Court's test of a penalty, so targets and bidders should take this into account.
Whilst Twitter is currently seeking an order of specific performance, the question arises - would a similar remedy be available for Australian transactions?
In Australia, specific performance is awarded where monetary damages would not be an adequate remedy for an aggrieved party.
Historically, this remedy has most commonly been granted to purchasers of land, on the premise that the subject land is unique, and the purchaser would not be able to go to market to obtain an identical lot.
In a M&A context, Australian courts are yet to properly consider specific performance as a remedy. However, applying the rationale above to the purchase of a business, a buyer could similarly argue that it has intentionally contracted to acquire a unique business, which would yield certain synergies with its own operations, and that an identical business combination is not available elsewhere.
However, from a seller's perspective, this argument seems to be more difficult to formulate. The first question to ask is what loss, if any, has the seller incurred? As the seller still retains the subject business, the loss suffered may only be any loss of opportunity or actual third-party costs of its professional advisers in connection with the failed transaction (as discussed earlier). Secondly, even if there was loss, sellers typically stand to receive consideration in the form of cash or shares and therefore it may be difficult to argue that monetary damages is not an adequate remedy. Furthermore, if the buyer's offer is dependent on securing financing, even if courts did order the buyer to complete the transaction, there is no guarantee that financers would provide funding especially after knowing that the buyer had attempted to withdraw.
Looking to United States cases
Whilst Australian case law is limited in this context, given the similar formulations of the law of specific performance in Australia and the U.S. (both are equitable remedies that the respective courts may choose to award where an award of damages would not be adequate), we can look to U.S. decisions for an indication of circumstances where specific performance might be awarded to sellers.
In the case of IBP Inc v Tyson Foods,12 Tyson Foods (Tyson) sought to acquire IBP. However, after a period of poor performance of IBP, Tyson, experiencing buyer's regret, sought to terminate the merger agreement.
As part of this agreement, IBP's shareholders had been offered Tyson's stock as consideration to have a “chance to share in the upside of what was touted by Tyson as a unique, synergistic combination”,13 and thus represented a unique opportunity for IBP's shareholders.
In reaching its decision to force Tyson to complete the merger, the Delaware Court of Chancery determined that any attempt to ascertain damages payable by Tyson would be "very difficult" and "staggeringly large", and that the remedy of specific performance would still be highly practical as Tyson admitted that the acquisition still made strategic sense, but it just wanted a lower purchase price given IBP's recent poor performance.14
The Court also considered the impact of a forced merger on Tyson, but determined that Tyson's constituents would be better served on the whole by an order of specific performance rather than Tyson paying out a large sum of damages.
In the second case of Genesco Inc v Finish Line,15 Finish Line (FL) agreed to acquire Genesco in an all-cash transaction. However, following signing, Genesco's financial performance dropped significantly, and FL, exhibiting buyer's remorse, began stalling. This resulted in an anxious Genesco suing FL to complete the acquisition.
The court ordered that FL complete the merger, finding that Genesco's business had been irreparably harmed as a result of the stalled merger, with the merger's uncertainty "negatively affect[ing] its stock price, vendor relationships, employee morale [and] public perception".16 In addition, the merger agreement had prevented Genesco from making significant capital expenditure and a significant amount of its resources had been dedicated towards the planned integration of the companies.17
Although forcing a buyer to follow through with a business acquisition is yet to be properly tested in Australia, these U.S. cases can provide guidance as to how arguments for specific performance may be advocated in Australian courts.
Worsening economic conditions increase the risk of purchasers attempting to back out of a sale after signing. While it can be unavoidable, there are ways sellers can protect their interests.
Among the best ways for a target to ensure it receives fair compensation in the event that a buyer reneges on its contractual commitment is the inclusion of a reasonable and enforceable liquidated damages clause. While sellers might not be directly compensated for loss of the opportunity to sell into the intended bid, at least the costs of the transaction and distraction caused by the bidder, to the business of the target, can be compensated.
Whilst it is common practice in U.S. M&A contracts to contemplate the remedy of specific performance, in both Australia and the U.S., it is ultimately up to the courts to decide to award this remedy. Given that the award of an equitable remedy is discretionary, the inclusion of such a clause in Australian M&A contracts may help to convince courts that the parties have contemplated such a remedy - and that it would therefore be appropriate.
This article was first published by Lawyers Weekly.
1 Shevill v Builders Licensing Board (1982) 149 CLR 620; Koompahtoo Local Aboriginal Land Council & Anor v Sanpine Pty Ltd & Anor (2007) 233 CLR 115)
2* *Hadley v Baxendale (1854) 9 Exch 341.
3 Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358;  VSCA 26.
4 Ibid at .
5 Progressive Mailing House Pty Ltd v Tabali Pty Ltd (1985) 157 CLR 17;  HCA 14).
6 Sellars v Adelaide Petroleum (1994) 197 CLR 1. **
7 Ibid at 355.
8 *Winky Pop Pty Ltd v Mobil Refining Australia Pty Ltd (2016) 13(9) CL 126. *
9 See Corporations Act 2001 (Cth) s 1041A.
10 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd  AC 79;Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656;  HCA 71.
11 Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205.
12 IBP Inc. V. Tyson Foods Inc, 789 a.2d 14 (del. Ch. 2001).
13 Ibid at .
14 Ibid at .
15 Genesco, Inc. v. Finish Line, Chancery Court for the State of Tennessee, NO. 07-2137-II(III).
16 Ibid at 40.
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